French retirement system responded to pension funds' failure

When many lobbies are promoting funded pension shemes, or capitalised retirement products, it is worth remembering how pay-as-you-go retirement shemes were set-up in France as a response to pension funds' failure.

As funded pensions become the new paradigm of retirement schemes, discarding pay-as-you go retirement systems for their inadequacy to pour demographic challenges, it is interesting to remind why and how some countries built such unfunded schemes, and the solution they provided when pension funds failed.

My Canadian friend is upset. Since he’s been working in France he doesn’t understand why he’s been deprived from his fundamental right to manage his retirement contributions himself, rather than being ripped off by a compulsory pay-as-you go (PAYG) system with a ridiculous return. His reaction reflects the growing belief, shared by some French people too, that capitalised funded and self-managed retirement schemes are more efficient than PAYG retirement systems. The insurance and asset management industries have promoted this view for decades. And the financial environment, especially in terms of inflation, has helped supporting this opinion. But it might not be so sure, as history shows.

When Social Security retirement was crafted in France, in 1945, ahead of Agirc, created in 1947, French pensions had been erased by two bloody wars which wrecked its economy. There was a need to rebuild everything from scratch. At that time there was a large working force with no savings, and a modest aging population with no retirement safety net. So designing a PAYG retirement system seemed appropriate and efficient to address the post war retirement dilemma. A funded system would not have been possible. First because people couldn’t afford to save in a country where resources were not even sufficient to rebuilt so many destroyed houses and bridges. Remember the country itself was helped out of bankruptcy by the Marshal plan in 1948.

Also, the new PAYG retirement system was a logical response to the bankrupt funded pensions that prevailed before. Few people in the Anglo-Saxon world remember that France experienced a capitalisation retirement, but it did. By the end of the 19th century, the emerging insurance and savings industry sold retirement products, more or less “entire life” insurance schemes based on voluntary defined contributions, mostly dedicated to the bourgeoisie who could afford them. Independent workers, craftsmen, merchants, and even farmers, drew their retirement living from their family working capital, inherited and transmitted to their sons (either shops, factories, clientele or the lands they owned).

There was of course a retirement problem for the growing salaried workforce, who wasn’t covered by any pension. It was a concern that some enlightened employers of large firms addressed with savings schemes for their employees, but most of the time salaried workers died before, or not many years after reaching retirement age. And many of those who survived were in such bad health that they ended in auspices taking care of them rather than enjoying their golden years.

Capitalisation retirement could have worked and expanded from its rich early adopters to a mass market, like it did in the UK or US, if inflation had not spoilt it. With WWI, prices in France jumped an average 20% each year from 1915 to 1920. Then, assets’ value was wiped off by deflation and the great depression of the 1930’s. Thereafter, inflation redoubled again during WWII and its following shortage years, leading prices to increase by up to 59% in 1948. As a result, total cumulated inflation between 1914 and 1949 reached 11 000%. In 35 years, the French franc purchasing power lost 99% of its real value. Capitalisation was ruined.

It is also very interesting to witness the historical shift, back toward funding pensions, at a time money doesn’t buy any serious and secured yield.